During the course of a divorce, any assets you and your spouse had will need to be divided. With the help of your lawyers or a mediator, you will decide who gets what property, how to divide your savings and how to divvy up the retirement accounts. Splitting up the 401(k)s and the IRAs is a bit trickier than simply dividing a regular savings account.
If you are employed and earn a certain amount of income each year, you can establish an individual retirement account or IRA. IRAs are usually a collection of savings options, such as certificates of deposit, stocks and mutual funds. There are several different types as well. The money put into a traditional IRA is deposited pre-tax, but you will have to pay tax on any withdrawals. Roth IRAs contributions are made after tax, but they are tax-free upon withdrawal. Usually, you cannot access the money in your IRA before age 59.5, without paying a penalty.
Transferring the Money
To avoid paying taxes or penalties on the money you give to your spouse from an IRA or money you receive from a spouse’s IRA, you need to do one of two things. You cannot simply pull out the money and write him a check, or else you will be responsible for the taxes, not him. You can transfer money from your IRA to one set up under his name, or you can set up a new IRA under your name, transfer a portion of the funds from the old account and then change the name on the old account.
401(k) to IRA
If you are transferring money from your 401(k) to a spouse’s IRA or vice versa, you need to complete a Qualified Domestic Relations Order, or QDRO. Once you get the money, you need to put it directly into your account to avoid paying taxes on it. You do have the option of taking a portion of the money and using it to pay bills, but you must do this before depositing it into your IRA to avoid paying early withdrawal penalties.
Warnings and Risks
To avoid any troubles down the road or a misunderstanding with the IRS, you should include the transfer of an IRA in the final divorce paperwork. Smart Money recommends including the following wording in the divorce papers: “Any division of property accomplished or facilitated by any transfer of IRA account funds from one spouse or ex-spouse to the other is deemed to be made pursuant to this divorce settlement and is intended to be tax-free under Section 408(d)(6) of the Internal Revenue Code.”
After the settlement, you have 60 days to make sure the money gets into your IRA or is transferred to another IRA to avoid any fees and taxes. If you receive a check and do not deposit within that time frame, it will count as a distribution, and you will be liable for taxes and penalties.